Dear Reader,
You need to consider a position that profits when the value of the pound falls. Today, I’ve got an idea for a way you can do this – a position that could make you profits as sterling falls AND protect you as the world economy continues to slide.
First, though, let’s understand the problem.
Here, we’ll call upon financial historian, Niall Ferguson, for a little reminder.
According to Ferguson, there’s a one in three chance that we’ll see a sterling crisis. He’s picked up the same thread that we have in previous issues of The Right Side. He’s concerned that the UK’s finances are in such a parlous state that there is the very real threat of a downgrading to our debt rating.
Why the UK is a “one in 18” country (and not in a good way)
That makes the UK very special – a “one in 18” kind of a country. But that’s not in a good way. What it means is that top credit ratings agency, Standard & Poor (S&P), awards 18 countries the AAA debt rating. Of those 18, the UK is the only one that it is considering downgrading.
That’s pretty dire. But let me explain why we’re thought of so badly...
Britain’s finances are in the worst state that they have ever been, other than during war times. In the first three months of 2009, our economy shrunk by 2.4%, the fastest rate in 51 years. And that was after economists had previously estimated the contraction would be 1.9%.
And as The Right Side’s Theo Casey points out, the UK has already broken Gordon Brown’s “golden rule”. That’s the one where he said that no more than 40% of our gross domestic product (GDP) could be in the “national debt”.
Well that’s been blown out of the water. According to S&P, that national debt could well rise to over 100% of GDP by 2013. The consequences would be unprecedented for the British economy.
As Theo explains, “In 1995, it happened to Canada (114% gross debt to GDP) and in 1998 it happened to Japan (120% gross debt to GDP). In both cases, the countries had their sovereign debt ratings downgraded.”
Both Canada and Japan were stripped of their AAA scores from the major ratings agencies. Their currencies weakened. And this is exactly what S&P is looking at now for the UK. That can only be bad news for the UK and bad news for the pound.
Why this sterling rally doesn’t have legs
So why, then has the pound been rallying? On Tuesday trade-weighted sterling, which is the pound as measured against a basket of major currencies, hit the highest level since November. Against the US dollar, the pound was at eight-month highs.
But the evidence doesn’t support this move. Last week the Bank of England said that it was concerned that the heavy losses sustained by banks are keeping Britain’s economy susceptible to another shock wave. That’s true. Banking is one of the major parts of the UK economy. That’s one of our major weaknesses. Pre-financial crisis, everything was rosy. But when it all turned ugly, with banks falling and the housing market slumping, then suddenly the economy is in trouble.
The Bank’s Governor, Mervyn King, actually said last week that the UK is facing a “long hard slog” to recovery. He’s demanded that the Government makes a “credible statement” of how it plans to reduce public debt. We’re still waiting for that statement. In the meantime, we question sterling’s strength.
So how do we play this? Well, the obvious way is actually trading the Forex markets direct. The pound will be very active here in the months ahead.
Most of the Forex action over the past few months has been centred on the dollar. Every time there’s a bit of bullish news for the world economy, stock markets around the world rally. At the same time, the dollar tends to fall. And vice versa. When there’s bad news, stocks fall and the dollar rallies as money rushes in a “flight to quality”. That’s because the dollar is still the world’s number one currency. But the trend is down, and that gives Forex traders a great thing to latch on to… trading in and out for short-term profits.
But with all the bad news coming out about the UK economy, it could be sterling that’s going to get all the attention in the months ahead. Forex traders are going to be making a lot of money from it. Not in a straight line down, of course. Forex, like any other market, zigs and zags. So you need to have a system – to play the trends in a safe way.
Of course, Forex is not for everyone. One guy who is really excited about the months ahead is Darryl Cox, who’s heading up a new Forex service we’re launching. He plays the trends – but also the “counter trends”. More about his thrilling FX Wiretap system soon.
In the meantime, remember that the world economy is still not fixed and that there are further financial shocks to come. Consider also that when government bailouts, “quantitative easing”, printing of money, call it what you will, finally start working, we are certain to see a crippling bout of inflation.
To protect you against both these outcomes, there’s one investment you should consider: gold. It’s the ultimate safe haven. And if we get a run on the pound, then gold will start to look very attractive to UK investors.
Good investing,
Frank Hemsley
For The Right Side
P.S. For more specific ways that you can protect yourself from the coming chaos in the UK and the damage it will cause to the pound – and a direct way to play gold – you should read Theo Casey’s excellent Fleet Street Letter, click here for details.
Note: Your capital is at risk when you invest in shares; never risk more than you can afford to lose. Please seek independent financial advice if necessary.
MARKET NOTES
China and India will lead the charge to recovery
BY SHIVVY ARORA
Let’s talk about the theory of ‘decoupling’. It suggests that emerging economies move independently of developed nations. And we’re now seeing it come into play.
While business cycles in advanced economies do have some impact on emerging economies, this link hasn’t been as strong as usual in current climes. The BRICs, notably China and India, have taken all the measures possible to keep their trade and finance above water – and they’re succeeding.
Take a look at the chart below...
We’ve tracked the Shanghai Composite Index (green line) and Bombay Sensex (orange line) versus the MSCI World Index which covers developed markets (black line), for the year-to-date. You can see how India and China’s stock markets have been hugely outperforming their developed peers this year.
The Shanghai Composite is up by 65%, while the Sensex has logged in 48% worth of gains. Compare this to a tiny 5.7% gain for the world index.
Some emerging markets are crushing their developed peers
Source: Bloomberg
EMs bottomed out in 2008 (circled) whilst developed world markets kept plunging and only bottomed out in March this year. Banking on their own fundamentals to make a comeback, EMs are defying the consensus that the US will be the first to cross the recovery finish line.
Like all global markets, EMs took a dive upon the initial financial collapse. But in what is a first, this year they will account for more than half of the world’s GDP.
Keep in mind that if we see a major pullback in western markets, EMs are likely to get affected too. But if you wait for this correction before ploughing in, you’ll find some prime investment opportunities in emerging markets.
The Daily Reckoning – When the bailout fails, the Feds will pass another one
BY BILL BONNER
Paris, France
Thursday, 2 July 2009
Everything is working out just like we thought it would. The stock market is performing as expected. The economy is on track. Even the politicians are doing what they thought they would.
Let’s begin with the stimulus/bailout/boondoggle/BS plan. As anticipated, it has failed. That is, the economy is getting worse, not better. It has failed the test set for it by its own creators. Back when the Obama Team was arguing for a big bailout bill, it warned that without a bailout unemployment would rise above 8% in 2009. ‘Pass this bill today,’ said Ben Bernanke, or words to that effect, ‘or there may not be a tomorrow for the US economy.’
Congress dutifully bent its back to the task of adding boondoggles to the bill and then okayed the measure. And here we are in the middle of 2009 and the unemployment rate is already at 9.4%.
It was obvious, even at the time, that the hacks in the administration had no idea what was going on. They were just guessing about the economy and taking advantage of the situation to pass out more money that taxpayers hadn’t even earned yet.
As predicted, the spending didn’t make the situation better; if anything, it probably made it worse – by delaying the process of destruction and hence retarding the process of creative reconstruction too.
We recall our other forecast too: when the bailout doesn’t work, they’ll pass another one. And so, in yesterday’s New York Times, there is David Leonhardt urging the pols to even bigger acts of absurdity:
“The economy really may need more help,” he says.
Yes, it will need more help. Especially if it keeps getting the kind of help it’s been getting.
The stock market is acting more or less as we thought it would too. The big bounce began on 9 March. It’s been almost 4 months now... and the bounce should be getting near its peak... and beginning to fall again. Just look at a chart of the Dow since March. You’ll see exactly that. Like a cannonball, it went up... and now it seems to be arching over for its fall to the ground.
Yesterday, the markets seemed to hang in mid air... The Dow was up 57… Oil stayed at $69. Only gold seemed to know where it was going – rising $13.
As stocks roll over, the economic news rolls over too.
In the USA Today yesterday was a report that said small businesses are going broke faster than expected. Small businesses are supposed to be the survivors. Like mammals in the Ice Age, they replace the dinosaurs...
To read the Daily Reckoning in full, click here.
P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.
